201012001H
SOAH DOCKET NO. 304-10-0027.26
CPA HEARING NO. 100,478
RE: *************
TAXPAYER NO.: *************
AUDIT OFFICE: *************
AUDIT PERIOD: October 1, 2001 THROUGH June 30, 2005
Limited Sales, Excise, And Use Tax/RFD
BEFORE THE COMPTROLLER
OF PUBLIC ACCOUNTS
OF THE STATE OF TEXAS
SUSAN COMBS
Texas Comptroller of Public Accounts
TREVOR MOORE
Representing Tax Division
*************
Representing Claimant
COMPTROLLER’S DECISION
************* (Claimant) is appealing the denial of its refund claim by the
Texas Comptroller of Public Accounts. Claimant contends that it is entitled to
a resale exemption for the Microsoft software licenses it transferred to its
customers while performing its taxable web hosting services. Comptroller
(Staff) rejects the refund claim on the grounds that care, custody, and control
of the software were not transferred to the customer. In his Proposal for
Decision (PFD) issued on September 30, 2010, the Administrative Law Judge (ALJ)
found that although custody and control had transferred, Claimant failed to
show by clear and convincing evidence that care transferred to its customers,
and, thus, recommended that the refund claim should be denied. Claimant filed
exceptions objecting to the ALJ’s recommendation and, in addition, renewed its
alternative argument that its purchases of the monthly software licenses from
Microsoft installed on out-of-state servers were not subject to Texas sales and
use tax, which the ALJ had concluded had been abandoned. In his Amended PFD
the ALJ recommends that the denial of the refund claim should be affirmed.
I. PROCEDURAL HISTORY, NOTICE & JURISDICTION
The case was submitted for an oral hearing. The hearing convened before ALJ
Peter Brooks on March 2, 2010. Claimant was represented by ************* of
COMPANY A. The Comptroller was represented by Assistant General Counsel John
Tresnicky. The record closed on August 3, 2010. The PFD was issued on
September 30, 2010. Claimant filed exceptions on October 18, 2010. Staff
filed its Reply on October 25, 2010. The Amended PFD represents the ALJ’s
recommended ruling on Claimant’s exceptions.
There are no issues of notice or jurisdiction in this proceeding. Therefore,
those matters are set out in the Findings of Fact and Conclusions of Law
without further discussion here.
II. REASONS FOR DECISION
A. Evidence Presented
Claimant offered the following exhibits, which were admitted into the record:
1. Exhibit No. 1: Refund Schedule;
2. Exhibit No. 2: Microsoft Invoices;
3. Exhibit No. 3: Service Provider License Agreement (SPLA);
4. Exhibit No. 4: Service Provider Use Rights (SPUR);
5. Exhibit No. 5: Letter from Microsoft regarding Change to SPLA;
6. Exhibit No. 6: Master Services Agreement (MSA); and
7. Exhibit No. 7: Customer Contract.
Claimant presented the testimony of INDIVIDUAL A, Claimant’s chief financial
officer, and INDIVIDUAL B, a Systems Analyst.
Staff offered the following exhibits, which were admitted into the record:
1. Exhibit No. 1: Refund claim letter;
2. Exhibit No. 2: Refund audit plan;
3. Exhibit No. 3: Refund denial letter;
4. Exhibit No. 4: Comptroller’s Rule 3.285;
5. Exhibit No. 5: Comptroller’s Rule 3.330; and
6. Exhibit No. 6: 60-day letter.
Staff presented the testimony of Ms. Lisa De La Luz, audit supervisor with the
Comptroller’s San Antonio office.
B. Background and Issues Presented
Claimant is a web hosting service provider headquartered in CITY A, Texas.
Claimant operated seven data centers during the refund period, three of which
were located in Texas. Claimant utilizes a vast network of computer servers to
support its customers’ web application and web traffic.
Claimant requested a refund of sales tax paid on purchases of Microsoft
software licenses made during the refund period of October 1, 2001, through
June 30, 2005. The Comptroller denied Claimant’s refund request in a letter
dated June 11, 2007. Claimant timely requested a refund hearing and contends
that its purchases of monthly software licenses from Microsoft qualified as
exempt purchases for resale because they were subsequently resold as an
integral part of a taxable service under TEX. TAX CODE ANN. Section 151.006 and
151.302. Claimant alternatively argues that its purchases of the monthly
software licenses from Microsoft installed on out-of-state servers were not
subject to Texas sales and use tax.
C. Facts Established
Claimant concentrates its operation solely on managed hosting, offering
Claimant’s customers administration and support of the servers and software,
and comprehensive internet infrastructure. Claimant’s services typically
include advanced monitoring, load balancing, elevated security, data storage,
stress testing, technical expertise, and content delivery. Claimant owns the
hardware, i.e., the data centers, networks, servers, and other devices, used in
its managed hosting services. Customers use the servers to operate large web
sites, store data or provide e-mail service. Claimant is also responsible for
installing, maintaining, and monitoring the hardware and the operating system
(OPS).
INDIVIDUAL A testified that customers typically contract with Claimant to host
the customer’s applications and web traffic. Claimant provides the managed
hosting services pursuant to the terms of the MSA and the individual Service
Order Form entered into by each customer. The Service Order Form is the
directive to Claimant to build a server and install particular software.
Claimant assigns to its customers one or more servers to host its web
application. There is at least one identifiable server dedicated to each
customer. Certain customers require more than one server because of heightened
data storage and web traffic requirements. The customer never purchases or
leases the server.
Once a server or servers have been assigned, Claimant installs the Microsoft
OPS and other requested software applications onto the server. Claimant
purchases the software licenses on a monthly basis. Claimant has allowed
customers with excess licenses of their own to have the software installed on
Claimant’s server. In such cases, Claimant will discount the customer’s
service costs to reflect the fact that Claimant will not have to pay Microsoft
for the software license.
Claimant pays Microsoft for the number of licenses that are activated and
installed on the servers. INDIVIDUAL A explained that Claimant acquires a
master DVD of the software with the right to make multiple copies and to
install copies of the software on the designated server. Claimant does not buy
individual copies. There is one master license key for all the software.
Claimant reports to Microsoft on a monthly basis the number of software
licenses that have been installed and activated. Microsoft is not notified of
the identity of the end user customer except when the customer is using a
significant number of licenses. Microsoft is interested in marketing to those
customers who use a large number of licenses. Microsoft has the authority to
audit Claimant to confirm that it is properly reporting and paying for the
number of licenses that have been activated.
Once the OPS and database application are installed, Claimant gives the
customer the administrator or root password so it can remotely access the
server through the OPS. INDIVIDUAL A testified that once the customer receives
the password the customer can do anything it wants with the software, including
customizing it, adding new operating system components, installing new software
applications, locking Claimant out of the system, and, theoretically, even
wiping the OPS off the server. The servers are bare except for the OPS that
has been installed by Claimant. The customers are now free to customize the
server. The customers will load their own web site on the server, if they
operate web sites. The customers may install additional software that modifies
the OPS. They may load their own applications. INDIVIDUAL A acknowledged that
sometimes Claimant may help or support this customization process
INDIVIDUAL A testified that the transfer of care, custody, and control begins
when Claimant puts the server online and sends the credentials and
administrator passwords to the customers. The customers now have root access
to the server. According to INDIVIDUAL A, this constitutes a transfer of
control. There is one system administrator designated on the Microsoft
software who is assigned the administrator password, which is carefully
guarded, because it allows the customer to take control of the servers.
INDIVIDUAL A testified that once access to the OPS is handed over to the
customer, it is in the driver’s seat. However, INDIVIDUAL A acknowledged that
effects of this transfer are not explicitly reflected in the MSA or customer
contract.
INDIVIDUAL A stated that, if the customer “crashes” the OPS due to its own
fault, Claimant can and will charge for remedying the situation. However,
other than a reference in the SPLA to the customer’s responsibility for harm
caused by unauthorized use of the OPS, there is no other explicit statement
imposing responsibility for any damage committed by the customer’s use of the
OPS.
INDIVIDUAL A testified that certain customers may lock Claimant completely out
of the OPS once the server has been put online. For example in the healthcare
area, the Federal Drug Administration imposes stringent requirements regarding
access to the servers in order to protect the confidentiality of the
information stored on the servers. These customers will lock out Claimant and
prevent it from logging onto the servers by changing the administrator
password. Claimant no longer has access to the root level and administrator
passwords. In some cases, where Claimant has been locked out, Claimant has had
to remove the customers’ servers from the secure area in the data center so
that the customer can work on the OPS. The customers who chose to lock out
Claimant number approximately 100 out of Claimant’s tens of thousands of
customers.
After Claimant installs the OPS, it will sometimes perform some configuration
of the OPS and automatic patching because the software is already dated to some
degree. Claimant will also customize the OPS if requested by the customer,
including, for example, adding an application.
INDIVIDUAL A testified that Claimant does perform regular maintenance for the
customers after the server and administrator passwords are transferred to the
customers. Claimant, on an ongoing basis, patches, monitors, and backups the
server. The backups are performed on a nightly basis, but only for those who
especially contract for this service. The patching is performed according to
the schedule that Microsoft releases the patches. INDIVIDUAL A conceded that
sometimes customers do their own patching, but insists that Claimant tends to
perform the patching for its customers. The monitoring performed by Claimant
includes confirming that the server is operational. Claimant may conduct a
port test to confirm that the applications are responding. Claimant will also
make sure that the web site is properly responding. If something goes wrong
Claimant will follow the rules of engagement, i.e., the instructions the
customer has given Claimant for responding to specific problems. For example
if the web site dies, Claimant may have been instructed to first try to revive
it. If Claimant cannot revive the web site, Claimant may then be directed to
contact the customer. Claimant’s reaction depends on the instructions given by
the customers. INDIVIDUAL A stated that some customers may want Claimant to be
more aggressive and others more conservative in responding to the problem that
it has identified.
Even after the server and OPS have been handed over to the customer, Claimant
often uses the software at issue by patching it with updates from Microsoft.
The customer determines the parameters for the patching. They are set out in
the rules of engagement developed with respect to each customer, which are
archived in CORE, a proprietary system owned by Claimant. Some customers will
perform their own patching, because they may have their own set of policies
that they want to apply to their designated servers. The customers might also
want to conduct testing before the patch is applied or perform the patching
according to their own schedule.
INDIVIDUAL A testified that, in addition to locking Claimant out of the OPS,
the customer exercises control over the OPS in a number of other ways. The
customers can create additional administrator accounts, giving more people
access to the OPS. The customers can even give permission to its own users.
In addition, there are services they can turn on or off. In fact, the
customers could also turn off the server. They also might elect to do their
own monitoring and patching. Once they get password control over the OPS they
can do anything to the OPS.
Although the customer can change the administrator password, thus locking out
Claimant, INDIVIDUAL A acknowledged that Claimant, as long as it also has
access to the administrator password, could change the password and, thus, lock
out the customer. INDIVIDUAL A questions why Claimant would ever want to
unilaterally change the password without the customer’s consent. Locking out
the customer would be tantamount to severing the business relationship with the
customer. However, if the rules of engagement allowed Claimant to do so,
Claimant could change passwords for security reasons. If the customer could
not first be contacted to secure such consent and time was of the essence,
Claimant might turn the server off by unplugging the network cable. INDIVIDUAL
A insisted that in only in a very few cases would they change the password
without having the prior approval of the customers.
Prior to November of 2001, Claimant provided its customers the software that
was purchased from Microsoft under an End User License Agreement (EULA). In
essence, Claimant would purchase boxed licensed Microsoft software. INDIVIDUAL
A testified that Claimant after purchasing the software would transfer the
software to its customers as part of the service rather than using the software
itself. However, the terms of the EULAs did not allow Claimant to rent, lease,
or lend any Microsoft product to its customers as part of its web hosting
services, though, according to INDIVIDUAL A, Microsoft knew that Claimant was,
in fact, providing the software to its customers through its web hosting
services.
Microsoft and Claimant entered into a letter agreement that was intended to
allow Claimant to provide its customers with the use of the licensed Microsoft
software. In the letter, which is dated November 7, 2001, [ENDNOTE: (1)] it
was agreed that Claimant would begin licensing software from Microsoft through
a SPLA, [ENDNOTE: (2)] which in turn is dated December 19, 2001. The letter,
which is entitled “Re: Resolution of Microsoft Software License Compliance
Issues,” recognized that, in the past, Claimant had been using Microsoft
software licensed under a EULA to provide hosted commercial services to its
customers, which is referred to as the “Prior Practice.” The letter agreement
explains that, “the EULA, which is an essential part of Microsoft’s Select,
Enterprise, Open, and retail pricing programs, does not allow a licensee to
rent, lease, or lend any Microsoft software product,” including the commercial
hosting of Microsoft software or the offering of Microsoft in the form of
services to third parties for a fee. The letter agreement acknowledges that
Microsoft grants license rights for this type of use only under a SPLA.
The letter agreement was intended to resolve all known prior license compliance
issues involving Claimant’s prior practices, including transferring use of the
Microsoft software licenses purchased by Claimant for its web hosting services:
Accordingly, Microsoft and CLAIMANT have agreed that CLAIMANT continuing use of
Microsoft software to provide hosted commercial services to CLAIMANT customers
will be licensed under the Services Provider License Agreement dated December 19,
2001, (as amended) (the SPLA) between Microsoft and CLAIMANT.
The parties agreed that the terms of the letter agreement “shall control over
any conflicting terms contained in the SPLA.” The letter agreement, thus,
specifically overrides Section 3(b)(1) of the SPLA, which provides that
Claimant “may not rent, lease, encumber, pledge, lend, copy, make available or
distribute the Software Products to any third party, except as expressly
permitted by this Agreement.”
D. ALJ’s Analysis and Recommendations
Contention No. 1: Sale for Resale
The sale for resale of a taxable item is exempted from sales tax. [ENDNOTE:
(3)] A sale for resale is a sale of tangible personal property to a purchaser
who acquires the property for the purpose of reselling it in the normal course
of business in the form in which it was acquired or as an attachment or
integral part of other tangible personal property or taxable service. [ENDNOTE:
(4)] In order to be entitled to the resale exemption, Claimant must firmly
establish that the care, custody, and control of the tangible personal property
were transferred to its customers as an integral part of the taxable service.
[ENDNOTE: (5)] Stated differently, Claimant must establish that its customers
had primary possession, and were primarily responsible for custody, control,
and care of the equipment at issue. [ENDNOTE: (6)] Claimant must show by clear
and convincing evidence that the Microsoft software licenses it claims were
purchased for resale under TEX. TAX CODE ANN. Section 151.302. [ENDNOTE: (7)]
The statute and rules dealing with the sale for resale exemption provide no
substantive guidance in determining whether care, custody and control have been
transferred. However, significant guidance was provided by the Austin
appellate court in Sharp v. Clearview Cable TV, Inc., 960 S.W.2d 424 (Tex. App.
- Austin 1998, pet. denied), which was faced with the question whether
Clearview Cable, a provider of wireless cable television, was entitled, under
TEX. TAX CODE ANN. Section 151.302(b), to purchase certain cable equipment
tax-free, because it had transferred care, custody, and control of the
equipment to its subscribers as an integral part of a taxable service.
The cable service was provided through the following equipment installed by
Clearview Cable: [ENDNOTE: (8)]
Outside the subscriber's home, an antenna receives a microwave signal, which
the down converter converts into a signal that can be received by the
subscriber's television set.
A connecting wire runs from the antenna and down converter into the
subscriber's home and connects with the power supply unit and set top
converter.
The power supply unit is then plugged into an electrical outlet inside the
subscriber's home to provide the antenna and down converter the electricity
needed to receive and convert the microwave signal.
Finally, the set top converter is connected by a cable wire to the television
set, allowing the subscriber to change channels as well as to program or block
certain channels.
The Comptroller agreed that each piece of the equipment was an integral part of
a taxable service. The Comptroller did not contest that the power supply unit
and set top converter qualified for the resale exemption. The Comptroller also
conceded that custody of all equipment was transferred to Clearview Cable's
customers, as it was either located inside or was attached to the customer’s
house. The Comptroller, however, declined to concede that care and control of
the antenna, down converter, and connecting wire were transferred to the
customers as provided by Section 151.302(b).
As the Comptroller conceded that custody had transferred to the subscribers,
the Court provided no guidance to follow in determining whether custody has
been transferred to a customer. The Court, however, still had to consider what
it means to transfer the care and control of equipment used to provide that
taxable service. The Court drew a distinction between the kind of transactions
involving Clearview Cable where ownership is not transferred and transactions
involving the sale for resale of tangible personal property where ownership is
transferred:
Unlike the classic “sale for resale” transaction where the ownership of the
taxable item is actually transferred from the retailer to the consumer,
ownership of the equipment used to provide a taxable service, such as a cable
service, remains with the cable company. In other words, while possession of
the equipment may ultimately be transferred to the cable subscriber, ownership
remains with the cable provider. In addition, unlike retailers and their
customers, there is a tacit assumption between the cable company and its
subscribers that at some point in the future the subscriber or cable provider
may terminate the cable service contract; whereupon the cable company will
reclaim its equipment. Therefore, unlike a retailer who relinquishes all
ownership in taxable goods sold to the ultimate consumer, the cable company
retains a vested ownership interest in the cable equipment during the term of
its service rental agreement with its subscriber. [ENDNOTE: (9)]
The Court in reaching a definition of care and control determined that both the
cable company and its customers are going to have some degree of joint care and
control over the equipment. [ENDNOTE: (10)] The cable company, as the service
provider and owner of valuable property, was motivated in servicing,
maintaining, managing, and guiding the equipment. And even more significantly,
the Court found that the customers, “as possessors of the equipment and users
of the service, inherently have a right to control the equipment and are
contractually bound to 'properly care' for it as well.” [ENDNOTE: (11)] The
Court based that conclusion on paragraph 5(a) of the subscription agreement
that provides in relevant part:
CARE OF EQUIPMENT. Subscriber shall properly care for [CLEARVIEW's] equipment
and shall not suffer or permit any damage, removal, or alteration of equipment.
[ENDNOTE: (12)]
The Court rejected the Comptroller's argument that in order for Clearview Cable
to take advantage of the sale for resale exemption it would have to completely
divest itself of all care and control of the cable equipment. Instead the
Court held that, “[p]rimary possession is determined by examining who primarily
controls and cares for such equipment.” [ENDNOTE: (13)]
The Court applied this standard and concluded that the cable company's
customers primarily controlled the outside equipment. This determination was
based on the Court's conclusion that it was the customer and not the cable
company that decided: “(1) when the equipment can be used; (2) how long the
equipment can be used; and (3) what, if any, programming is going to be
received by the antenna and converted into a signal that can be received by the
subscriber's television set.” [ENDNOTE: (14)] Not only do the customers
control the ultimate piece of the integrated system, i.e., the power supply,
they also decide who can use the equipment and where the equipment should be
placed.
The Court also concluded that the customers primarily cared for the outside
equipment. The Court's conclusion was based on its determination that the
customers were contractually bound to “properly care” for the outside
equipment. [ENDNOTE: (15)] The customer's proper care consisted primarily of
not intentionally harming or damaging the equipment. In the Court's eye the
primary care exercised by the subscribers was that of benign neglect; i.e., to
simply leave the equipment in place and undisturbed. In contrast, the cable
company's responsibility for the equipment was purely reactionary, i.e., to
“care” for the equipment when it is notified that the equipment is defective,
damaged, lost, or stolen.
Custody
Neither the statute, rules, nor Clearview Cable TV are of any assistance in
determining whether custody of the Microsoft licenses was transferred to
Claimant’s customers. However, there are a handful of Comptroller decisions
and rulings that have addressed to a significant degree whether custody has
been transferred to a customer. In Letter Ruling State Tax Automated Research
System (STAR) Accession No. 9808769L (August 24, 1998), the Comptroller ruled
that the cable and splitters installed by a cable service provider in apartment
complexes and commercial buildings would not qualify for the sale for resale
exemption if the cable and splitters were not located on the premises of the
individual subscribers, i.e., the individual apartment or office. In
Comptroller’s Decision No. 43,728 (2004), a hotel operator contended that it
was due a refund of the tax paid on the telephone handsets it installed in the
hotel guest rooms because the care, custody, and control of the equipment was
transferred to the guest. The Comptroller distinguished the case from
Clearview Cable TV, noting that the hotel retained custody and control of the
guest room telephone handsets. The hotel guests only rented the rooms for a
limited time period, generally in increments of 24 hours. Although the
Comptroller found that the telephone handsets were made available for the
guests to use, the Comptroller concluded that availability was not synonymous
with custody. Only the hotel operator could “remove or alter the handsets,
which are attached to the wiring in its real property, and are intended to be
semi-permanent fixtures in the guest room.”
An even more detailed consideration of the factors to consider in determining
whether custody has transferred is found in COMPTROLLER’S DECISION NO. 41,730
(2004), in which the Comptroller considered the question whether the operator
of a private club providing golf, tennis, swimming, food and beverage services
had transferred care, custody, and control of the lockers to its members. The
members, in addition to the monthly membership dues, rented a locker
indefinitely on a month-to-month basis. The Comptroller accepted the private
club operator’s contention that the member maintains custody of the locker
contents, but rejected its contention “that the member obtains custody of the
locker itself because the member has exclusive use of it.” The Comptroller
held that “‘use’ is not synonymous with ‘custody,’” and concluded that although
the private club operator allowed the member certain limited custodial
privileges, such as the right to temporarily personalize the locker interior,
it was the private club operator “who retains permanent custodial rights over
the lockers located on its property.” The Comptroller also found that the
member’s access to the lockers was determined by the private club operator,
because it set the dates and hours when the facilities would be open. The
Comptroller acknowledged that the issues of custody and care were interrelated,
as it found that the member’s ability to make interior alterations to the
locker was dependent on the private club operator’s permission.
The question of the transfer of custody in the instant case would be readily
settled, under the available precedent, if it involved the transfer of the
server itself, which is located in a secure spot within the Claimant’s data
center. The customers are unable to physically touch the server. Claimant,
however, is not arguing that the server was transferred, but contends that it
has transferred to its web hosting customers custody of the Microsoft software,
which it has installed as the OPS on the servers. Claimant argues that access,
and thus control over the OPS, is transferred when the server is put online and
the root or administrator passwords are given to the customers. The record
establishes that the customers, at that point, have full access to the OPS;
however so does Claimant, as long as the customers have not changed the
password. Unlike the use of the lockers described in COMPTROLLER’S DECISION
NO. 41,730, Claimant does not set the terms and conditions under which the
customers have access to the OPS, but rather it is the customer who, pursuant
to its rules of engagement, which are recorded in Claimant’s CORE system, sets
the parameters of Claimant’s access to the OPS. Although, both Claimant and
its customers have custody over the OPS, it is the customer who has primary
custody over the OPS.
Care
In Clearview Cable TV, the taxpayer prevailed because it could show that the
subscribers were contractually bound to care for the cable equipment. The
subscribers explicitly agreed that they would properly care for Clearview
Cable’s equipment and not suffer or permit any damage, removal, or alteration
of the cable equipment. Claimant, in the instant case, relies on Section 9 of
the MSA, which provides that while Claimant is responsible for performing the
specific security services described in the customer’s Service Order Form and
in the MSA, the customer is responsible for unauthorized use of the services,
which would include the OPS, by any person, unless such unauthorized use
results from Claimant’s failure to perform its obligations under the agreement.
This provision is much narrower that the contractual obligation cited in
Clearview Cable TV. Moreover, in contrast with Clearview Cable TV, in which
the Court described the cable company's responsibility for the equipment as
purely reactionary, i.e., to “care” for the equipment when it is notified that
the equipment is defective, damaged, lost, or stolen; Claimant actively
participates in the maintenance of the OPS by performing the patching of the
OPS and monitoring the server and the OPS. Some of the customers elect to
perform the patching themselves, but most of the customers want Claimant to do
the patching. Claimant monitors the functioning of the server and the OPS. If
Claimant detects a malfunction, its reaction is dictated by the rules of
engagement for the particular customer. It is difficult to ascertain, based on
the record developed in this case, whether the customers or Claimant are
primarily responsible for the care of the Microsoft software, given the extent
of Claimant’s role in maintaining the OPS. This is especially true since that
determination must be made by clear and convincing evidence. Such a
determination would have to be made on a customer-by-customer basis by
reviewing both the customer’s Service Order Form and rules of en
gagement. The only context in which a general determination could be made is
with respect to those customers who have elected to lock out Claimant from any
access to the OPS. However, these customers have not been identified in the
record, other than by INDIVIDUAL A’ testimony that approximately 100 customers
completely locked out Claimant from the OPS.
Control
Claimant argues that once it gives the root or administrator password to its
customer it has transferred control over the OPS to the customer, who is free
to load any other applications, and otherwise further customize the OPS. The
customer could even lock out Claimant from accessing the OPS. Claimant could
only access the OPS with the customer’s prior approval, as evidenced in the
rules of engagement, or in the case of an emergency, with the customer’s
consent. Claimant acknowledges that as long as it has the administrator
password, and it has not been changed by the customer, it can freely access the
OPS. Yet exercising such control, contrary to the customer’s instructions,
would not be in Claimant’s best interests. In the rare case of an emergency
where it did not have the preapproval of the customer to access the OPS and
could not secure the customer’s consent, Claimant could always turn off the
server by disconnecting the network cable, thus, preventing any further input
to the OPS. Given the restrictions the customers may impose on the control
that Claimant retains through its access to the administrator password, it is
the customer who exercises primary control over the OPS.
Recommendation
The ALJ finds that the customers had primary custody and control over the
Microsoft software that was transferred to its customers as part of its web
hosting service. The ALJ, however, finds that Claimant did not show by clear
and convincing evidence that it transferred primary care over the software to
the customers. Consequently, the ALJ concludes that Claimant did not transfer
the care, custody and control over the Microsoft software required to qualify
for the sale for resale exemption. Claimant’s refund claim should be denied.
Contention No. 2: Out-of-State Purchases
Claimant raised the alternative argument that its purchases of the Microsoft
monthly software licenses installed on out-of-state servers are not subject to
Texas sales and use tax. Claimant’s explanation of this contention is sketchy
at best. Claimant stated that it operates four data centers outside of Texas.
One is located in CITY B , Virginia, while the remaining three are located in
CITY C, the United Kingdom. According to Claimant, it installs the Microsoft
operating systems and database applications on each server used out of state.
Claimant has not referred to any evidence supporting this contention. Staff
objects that Claimant has not provided documentation that specific operating
system software was installed on specific out-of-state servers and that they
were not remotely accessed by Texas users.
Claimant bears the burden of proving by a preponderance of the evidence under
34 TEX. ADMIN. CODE Section 1.40(2)(B) that the purchases of the operating
system software were nontaxable because the software was installed out of
state. Claimant’s alternative contention should be denied as it has not
offered any evidence supporting the contention.
III. FINDINGS OF FACT
1. ************ (Claimant) is a web hosting service provider headquartered in
CITY A, Texas. Claimant operated seven data centers during the refund period,
three of which were located in Texas. Claimant utilizes a vast network of
computer servers to support its customers’ web application and web traffic.
2. Claimant requested a refund of sales tax paid on purchases of Microsoft
software licenses made during the refund period of October 1, 2001, through
June 30, 2005. The Comptroller of Public Accounts (Comptroller) denied
Claimant’s refund request in a letter dated June 11, 2007.
3. Claimant timely requested a refund hearing and contends that its purchases
of monthly software licenses from Microsoft qualified as exempt purchases for
resale because they were subsequently resold as an integral part of a taxable
service under TEX. TAX CODE ANN. Section 151.006 and 151.302.
4. On September 1, 2009, the case was referred to the State Office of
Administrative Hearings for an oral hearing.
5. Comptroller Staff provided a notice of filing to Claimant that contained a
statement of the date and time of the hearing, the nature of the hearing; a
statement of the legal authority and jurisdiction under which the hearing was
to be held; a reference to the particular sections of the statutes and rules
involved; and a short, plain statement of the matters asserted.
6. The hearing convened on March 2, 2010.
7. The record closed on August 3, 2010.
8. Claimant offers its customers administration and support of the servers and
software, and comprehensive internet infrastructure. Claimant’s services
typically include advanced monitoring, load balancing, elevated security, data
storage, stress testing, technical expertise, and content delivery.
9. Claimant owns the hardware, i.e., the data centers, networks, servers, and
other devices, used in its managed hosting services. Customers use the servers
to operate large web sites, store data or provide e-mail service. Claimant is
also responsible for installing, maintaining, and monitoring the hardware and
Microsoft software as the operating system (OPS).
10. Claimant typically contracts with a customer to host the customer’s
applications and web traffic. Claimant provides the managed hosting services
pursuant to the terms of the Master Services Agreement (MSA) and the individual
Service Order Form entered into by each customer. The Service Order Form is
the directive to Claimant to build a server and install particular software.
11. Once a server or servers have been assigned to a customer, Claimant
installs the Microsoft OPS and other requested software applications onto the
server. Claimant purchases the software licenses on a monthly basis.
12. Claimant and Microsoft entered into a letter agreement dated December 19,
2001, which authorized Claimant to use Microsoft licensed software to provide
hosted commercial services to its customers under a Service Provider License
Agreement (SPLA) even though the SPLA normally would prohibit Claimant from
renting, leasing, lending, copying, or making available the software to its
customers.
13. Once the OPS and database application are installed on the server,
Claimant gives the customer the administrator or root password so it can
remotely access the server through the OPS. Once the customer receives the
password the customer can do anything it wants with the software, including
customizing it, adding new operating system components, installing new software
applications, locking Claimant out of the system, and even wiping the OPS off
the server. Claimant, upon the customer’s request, will assist in the
customizing.
14. Certain customers elect to lock Claimant completely out of the OPS once
the server has been put online. These customers will lock out the Claimant and
prevent it from logging onto the servers, by changing the administrator
password. Claimant no longer has access to the root level and administrator
passwords.
15. Out of Claimant’s tens of thousands of customers approximately 100 of
Claimant’s customers chose to lock it out of the OPS.
16. Claimant does perform regular maintenance for the customers after the
server and administrator passwords are transferred to the customers. Claimant,
on an ongoing basis, patches, monitors, and backups the server. The backups
are performed on a nightly basis, but only for those who especially contract
for this service.
17. Sometimes customers do their own patching, although most customers want
Claimant to perform the patching for its customers. The customer determines
the parameters for the patching. They are set out in the rules of engagement.
18. The monitoring performed by Claimant includes confirming that the server
is operational and that the web site is properly responding. If something goes
wrong Claimant will follow the rules of engagement, i.e., the instructions the
customer has given Claimant for responding to specific problems.
19. The customer exercises control over the OPS in a number of ways, other
than locking Claimant out of the OPS. The customers can create additional
administrator accounts, giving more people access to the OPS, including their
own users.
20. The customers can turn on and off certain services. Customers can also
turn off the server.
21. Claimant, as long as it also has access to the administrator password, can
change the password and thus lock out the customer.
22. Claimant would normally not lock out the customer from the OPS unless it
had secured its consent.
23. Section 9 of the MSA provides that while Claimant is responsible for
performing the specific security services described in the customer’s Service
Order Form and in the MSA, the Customer is responsible for unauthorized use of
the services, which would include the OPS, by any person, unless such
unauthorized use results from Claimant’s failure to perform its obligations
under the agreement. There is no other provision explicitly imposing
responsibility on Claimant for any damage done to the OPS.
24. Claimant operates four data centers out of state. One is located in CITY
B, Virginia, while the remaining three are located in CITY C, the United
Kingdom.
25. Claimant did not offer any evidence supporting its contention that it
installed Microsoft licensed operating system software on servers located in
the four out-of-state data centers.
IV. CONCLUSIONS OF LAW
1. The Comptroller has jurisdiction over this matter pursuant to TEX. TAX CODE
ANN. ch. 111.
2. The State Office of Administrative Hearings has jurisdiction over matters
related to the hearing in this matter, including the authority to issue a
proposal for decision with findings of fact and conclusions of law pursuant to
TEX. GOV’T CODE ANN. ch. 2003.
3. The Comptroller provided proper and timely notice of the hearing pursuant
to TEX. GOV’T CODE ANN. ch. 2001.
4. In order to be entitled to the resale exemption, Claimant must firmly
establish that the care, custody, and control of the tangible personal property
were transferred to its customers as an integral part of the taxable service.
TEX. TAX CODE ANN. Section 151.302(b) and 151.006(3).
5. Claimant must prove it is entitled to the resale exemption by clear and
convincing evidence. 34 TEX. ADMIN CODE. Section 1.40(2)(A).
6. Claimant must establish that its customers had primary possession, and were
primarily responsible for control and care of the equipment at issue. See Sharp
v. Clearview Cable TV, Inc., 960 S.W.2d 424 (Tex. App. - Austin 1998, pet.
denied).
7. Based on Findings of Fact Nos. 13 - 15, and Conclusions of Law Nos. 4 - 6,
Claimant established that it transferred custody of the Microsoft software to
its customers.
8. Based on Findings of Fact Nos. 13 - 15, and Conclusions of Law Nos. 4 - 6,
Claimant established that it transferred control of the Microsoft software to
its customers.
9. Based on Findings of Fact Nos. 16 - 19 and 24, and Conclusions of Law Nos.
4 - 6, Claimant failed to establish by clear and convincing evidence that it
transferred care of the Microsoft software to its customers
10. Based on Conclusions of Law Nos. 7 - 9, Claimant failed to establish that
it was entitled to the sale for resale exemption for its purchase of the
Microsoft software licenses.
11. Claimant bears the burden under 34 TEX. ADMIN. CODE Section 1.40(2)(B) of
proving by a preponderance of the evidence that the Microsoft licensed
operating system software was installed on out-of-state servers.
12. Based on Findings of Facts Nos. 24 and 25 and Conclusion of Law No. 11,
Claimant failed to establish that it installed software on out-state servers.
13. Based on the foregoing Findings of Fact and Conclusions of Law, Staff’s
denial of the refund claim should be affirmed.
Hearing No. 100,478
ORDER OF THE COMPTROLLER
On September 30, 2010, the State Office of Administrative Hearings’
Administrative Law Judge (ALJ), Peter Brooks, issued a Proposal for Decision in
the above-referenced matter to which Claimant filed Exceptions on October 18,
2010. Staff filed a Response on October 25, 2010. An Amended Proposal for
Decision was issued on November 18, 2010, and no exceptions were filed. The
Comptroller has considered the Exceptions, Response, and the ALJ’s
recommendation letter and determined that the ALJ’s Amended Proposal for
Decision, except for minor changes to correct typographical or clerical errors,
should be adopted without change and this Decision represents the ruling
thereon.
The above Decision is approved and adopted in all respects. This Decision
becomes final twenty days after the date Claimant receives notice of this
Decision. If either party desires a rehearing, that party must file a motion
for rehearing, which must state the grounds for rehearing, no later than twenty
days after the date Claimant receives notice of this Decision. Notice of this
Decision is presumed to occur on the third day after the date of this Decision.
Signed on this 21st day of December 2010.
SUSAN COMBS
Texas Comptroller of Public Accounts
by: Martin A. Hubert
Deputy Comptroller
ENDNOTE(S)
(1) Claimant’s Exhibit No. 5.
(2) Claimant’s Exhibit No. 3.
(3) TEX. TAX CODE ANN. Section 151.302(a).
(4) TEX. TAX CODE ANN. Section 151.006(a)(1).
(5) TEX. TAX CODE ANN. Section 151.302(b) and 151.006(3).
(6) See Sharp v. Clearview Cable TV, Inc., 960 S.W.2d 424 (Tex. App. - Austin
1998, pet. denied).
(7) 34 TEX. ADMIN CODE Section 1.40(2)(A).
(8) See Clearview Cable TV, at 2-3.
(9) Id. at 427.
(10) Id.
(11) Id. at 428.
(12) Id.
(13) Id.
(14) Id.
(15) Id.
ACCESSION NUMBER: 201012001H
SUPERSEDED: N
DOCUMENT TYPE: H
DATE: 12/21/2010
TAX TYPE: SALES